Delaware avoidance action

Introduction

In July of 2011, the Chapter 7 Trustee (the “Trustee”) in the Ultimate Acquisition Partners (formerly “Ultimate Electronics”) bankruptcy began filing complaints to avoid and recover payments which the Trustee alleged were avoidable transfers under section 547 of the United States Bankruptcy Code.  Earlier this month, the Trustee filed another round of preference complaints seeking to recover what he contends are preferential transfers.  This post will look briefly at the Ultimate’s business, why the company filed for bankruptcy and provide some general information regarding defenses to a preference action.

Reasons Ultimate Electronics Filed for Bankruptcy

Prior to going in to bankruptcy, Ultimate Electronics sold high-end home entertainment and consumer electronics throughout the western and mid-western United States.  Based in Thornton, Colorado, Ultimate Electronics employed approximately 1,500 employees before it filed for bankruptcy.  According to pleadings filed with the Delaware Bankruptcy Court, Ultimate attributed its bankruptcy filing to a “significant downturn in business at certain of the Debtors’ locations, coupled with refusal by certain of Debtors’ vendors to ship goods to the Debtors on open credit.”  By filing for bankruptcy, Ultimate was hoping to close under performing stores, re-negotiate its leases and improve its profitability.

Conversion from Chapter 11 to Chapter 7

Plans quickly changed for Ultimate after the company filed for bankruptcy.  Nine days after filing for bankruptcy, on February 4, 2011, the company filed a motion with the Bankruptcy Court seeking approval of going out of business sales.  Within two months of filing the going out of business motions, Ultimate had sold substantially all of its assets.

On April 25, 2011, Ultimate Electronic’s DIP lender issued a “Termination Event” under Ultimate’s Final Cash Collateral Order (the “DIP Order”).  Under the DIP Order, if the lenders’ termination notice is not contested within five business days, the automatic stay is lifted in favor of Ultimate’s DIP lender.  Ultimate filed its Motion to Convert to Chapter 7 one day after receiving the Termination Event.  The Bankruptcy Court converted Ultimate’s bankruptcy to a Chapter 7 liquidation on May 3, 2011.  The following day, Alfred T. Giuliano was appointed the Chapter 7 Trustee for Ultimate Electronic’s bankruptcy proceeding.

The Preference Actions

The Trustee in the Ultimate Electronics bankruptcy is represented by the law firm Pachulski Stang Ziehl & Jones LLP.  The bankruptcy proceeding, along with the preference actions filed by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath is a former Chief Judge of the Delaware Bankruptcy Court.

For reader’s looking for more information concerning preference litigation, attached is a booklet I prepared on the subject:  “A Preference Reference:  Common Issues that Arise in Delaware Preference Litigation.”

This week, Edward Gavin, the liquidating trustee (the “Trustee”) for the Ultimate Escapes bankruptcy, filed preference complaints against several defendants.  Under the complaints, the Trustee alleges that the defendants received preferential transfers that are avoidable under 11 U.S.C. section 547 of the Bankruptcy Code.  For those unfamiliar with this bankruptcy proceeding, Ultimate Escapes (“Ultimate” or the “Debtor”) filed petitions for bankruptcy in the Delaware Bankruptcy Court on September 20, 2010.

Prior to bankruptcy, Ultimate was in the luxury destination club industry.  The company provided members with access to high-end residences and resorts in the U.S. and around the world.  According to the company’s declaration in support of its bankruptcy pleadings (the “Declaration”),  Ultimate operated 119 “luxury club residences,” most of which were owned by the Debtor.  Decl. at *2.

Ultimate blames its bankruptcy on the declining sales that followed the 2008 recession.  As demand for the company’s services declined, Ultimate was faced with a liquidity problem and inability to service its debt.  The company tried unsuccessfully to negotiate an out of court restructuring with its lenders.  Once negotiations failed, Ultimate decided that filing for bankruptcy would provide the most value to creditors.  Decl. at *3.

Approximately fourteen (14) months after filing for bankruptcy, Ultimate filed its Second Amended Chapter 11 Liquidating Plan.  On December 8, 2011, the Bankruptcy Court entered an order confirming the Debtor’s Plan.  The Plan of Liquidation became effective on January 3, 2012 and the Trustee was named soon after.  The Ultimate bankruptcy proceeding is before Judge Brendan Shannon.  The Trustee is represented by the law firm Polsinelli Shughart.

Introduction

In January, Jeoffrey L. Burtch, the Chapter 7 Trustee (the “Trustee”) in the ManagedStorage bankruptcy proceeding, commenced adversary proceedings in the Delaware Bankruptcy Court against various defendants.  As alleged in the complaints, the Trustee claims that the defendants received “preferential” payments from ManagedStorage (dba “Incentrix Solutions” or “Incentrix”) and that the payments are subject to avoidance and recovery under the United States Bankruptcy Code (the “Bankruptcy Code”).  This post will look at the Incentrix bankruptcy, why the company filed for bankruptcy as well as some of the issues that arise in preference litigation.

The Bankruptcy Proceeding

Incentrix filed Chapter 11 petitions for bankruptcy in February of 2009.  At the time the company filed for bankruptcy, it was based in Denver, Colorado and operated offices in Illinois, Washington, California, New Jersey, Pennsylvania, New York, Oregon, Texas, Colorado and the United Kingdom. According to a Declaration of Incentrix’s Chief Financial Officer (the “Declaration” or “Decl.”), the company’s business consisted primarily of the resale of technology hardware and software products, as well as maintenance contracts.  Decl. at *3.  Aside from its resale business, the company also provided managed IT services.  Decl. at *3.

Events Leading to Bankruptcy

Approximately two years prior to filing for bankruptcy, Incentrix entered into a secured revolving loan agreement (the “Revolver”) with certain of its lenders.  Under the Revolver, Incentrix could borrow up to $20 million.  In 2008, following the recession in the U.S. and Europe, Incentrix’s customers began delaying the purchase of IT hardware and software.  As a result of the drop in sales, Incentrix was unable to generate sufficient “trade receivables collateral” under the Revolver.  Without funding under the Revolver, Incentrix could not pay its trade creditors in a timely manner.  Decl. at *17. This, in turn, led to Incentrix’s vendors placing the company on a “credit hold,” further reducing the company’s ability to generate trade receivables collateral.  Decl. at *18.

The Preference Actions

On November 3, 2010, the Bankruptcy Court entered an order converting Incentrix’s bankruptcy proceeding from a chapter 11 reorganization to a chapter 7 liquidation.  The Trustee was appointed as Chapter 7 Trustee one day later, on November 4, 2010.  As alleged in the complaints, the Trustee seeks the avoidance and recovery of transfers pursuant to sections 547 and 550 of the Bankruptcy Code.

The Incentrix bankruptcy, as well as the preference actions commenced by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as Chief Judge of the Delaware Bankruptcy Court.  The Trustee in Incentrix is represented by the law firm Cooch and Taylor, P.A..

In November, Jeoffrey Burtch, the Chapter 7 Trustee in the AE Liquidation bankruptcy (formerly “Eclipse Aviation”), began filing preference actions against various creditors of Eclipse.  Eclipse Aviation began as a New Mexico manufacturer of small jet aircraft.  The company filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on November 25, 2008.  As stated in the Affidavit in Support of Eclipse’s Bankruptcy Motions,  Eclipse began approximately 12 years ago as a manufacturer of aircraft intended for individual pilots, small companies seeking corporate aircraft and air taxi services serving smaller hubs.  In order to produce affordable aircraft, Eclipse created a “manufacturing strategy” based upon low production costs and high volume.

Over time, Eclipse was unable to meet the production goals necessary to sustain a positive cash flow. Eclipse tried to increase production through additional financing and increase its revenue by raising its prices. When neither were successful, Eclipse began to lay off employees and seek a buyer. After looking at all its options, Eclipse decided that a sale of its assets under section 363 of the Bankruptcy Code was the best way to proceed.

On March 5, 2009, the Eclipse bankruptcy converted from a chapter 11 reorganization to a chapter 7 liquidation.  Jeoffrey Burtch was appointed the chapter 7 trustee the same day the case converted to chapter 7.  The Trustee is represented by the law firm Cooch and Taylor, P.A.  This bankruptcy proceeding, as well as the preference actions, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as the Chief Judge of the Delaware Bankruptcy Court.

Introduction

Recently, over 180 adversary actions were filed in the MPC Computers bankruptcy.  The adversary actions fall generally in to two categories – preference actions filed by MPC’s Committee of Unsecured Creditors and breach of contract actions filed by MPC.  This post will look briefly at why MPC filed for bankruptcy and discuss what may happen next now that the adversary actions are underway.

Background on the MPC’s Business and Events Leading to Bankruptcy

As reflected in the declaration of MPC’s CFO,  Curtis Akey,  MPC (formerly Gateway) provided computer-based products and services to mid-sized businesses, government agencies and educational organizations (read here the Declaration of Gateway’s CFO in Support of Debtors’ Chapter 11 Petitions).  MPC-Pro, LLC acquired Gateway in October of 2007.  As a result of this acquisition,  MPC’s revenue rose to $895 million.  Six months after the acquisition, the company decided to stop manufacturing at its Tennessee facility and outsource a substantial portion of manufacturing to Flextronics at its Juarez, Mexico facility.

The Flextronics’ facility came on line slower than planned and with limited production.  On October 28, 2008, Flextronics informed MPC that it was discontinuing its supply of products and services to MPC.  As stated in the Akey Declaration, MPC’s purchase of Gateway, followed by the unsuccessful outsourcing to Flextronics and the overall lack of liquidity led to the present bankruptcy filing.

The Adversary Actions

According to the adversary complaints filed by MPC’s Creditors’ Committee, the Committee and MPC entered into a stipulation on October 12, 2010.  The stipulation appoints the Committee as representative of MPC and confers standing on the Committee for purposes of investigating and prosecuting avoidance actions under chapter 5 of the Bankruptcy Code.  Judge Walsh, the bankruptcy judge presiding over the MPC bankruptcy, approved the stipulation on October 21, 2010.

Unlike the preference actions, the breach of contract actions are brought directly by MPC (versus the Creditors’ Committee).  Through these actions, MPC alleges various defendants received goods from the Debtors which were never paid for.

Given the size and frequency of bankruptcy filings in Delaware, judges in the Delaware Bankruptcy Court often (but not always) enter uniform scheduling orders that provide parties with similar dates to serve discovery, complete motion practice, etc.. Scheduling orders in preference actions usually allow the parties 90 to 120 days to complete fact discovery and require the parties participate in mediation.  Click here to review a copy of one of the form scheduling orders posted to the Delaware Bankruptcy Court’s web page.

The MPC bankruptcy, including the adversary actions, are before Honorable Peter J. Walsh.  Judge Walsh is the former Chief Judge of the Delaware Bankruptcy Court.  MPC is represented by Reed Smith LLP and the Creditors’ Committee is represented by Drinker Biddle and Reath LLP.

In August, the Chapter 7 Trustee in the National Wholesale Liquidators (“NWL”) bankruptcy filing approximately 90 preference actions.  Just recently,  the Trustee filed over 100 more preference actions in NWL.  In November of 2008, I wrote about the commencement of NWL bankruptcy (read my prior post concerning the NWL bankruptcy here).  As indicated in the prior post, NWL filed for bankruptcy in agreement with its lenders that it would either find a buyer while in bankruptcy, or convert and liquidate under Chapter 7 of the Bankruptcy Code.  The NWL bankruptcy converted to Chapter 7 on February 26, 2009.

The Chapter 7 Trustee hired Archer and Greiner to represent him in this bankruptcy proceeding.  Pursuant to the summons filed with the most recent preference actions, the Court scheduled a pretrial conference on February 16, 2011.  These adversary actions, as well as the NWL bankruptcy proceeding, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as Chief Judge of the Delaware Bankruptcy Court.

Introduction

On September 1, 2010, Judge Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware issued a decision finding that the payment practices between a creditor and debtor satisfied the ordinary course of business defense.  Judge Sontchi’s decision is worth review as it provides a current look at one of the most common defenses to a preference action.  Better still, motions for summary judgment based on ordinary course of business often fail due to fact intensive nature of the defense.  It is helpful, then, to understand the reasons for the court granting summary judgment and the facts the court found significant.

Background

Archway Cookies (“Archway”) filed for chapter 11 bankruptcy protection on October 6, 2008.  Approximately three months after filing for bankruptcy, the company converted to a chapter 7 liquidation and a chapter 7 trustee (the “Trustee”) was appointed.  The Trustee commenced several avoidance actions, one of which was against Detroit Forming, Inc. (“DFI”).  DFI manufactures plastic trays which it sold to Archway for approximately two years prior to the petition date.  Pursuant to the parties agreement, DFI shipped goods to Archway on net 20 day payment terms.  Opinion at *3.

Preference Analysis

Section 547(c)(2)(A) of the Bankruptcy Code permits a recipient of an otherwise avoidable transfer to keep the transfer if it was made “in the ordinary course of business or financial affairs of the debtor and the transferee.”  11 U.S.C. Sec. 547(c)(2)(A).  The party relying on the defense carries the burden of proof by a preponderance of the evidence.  Opinion at *9.

The court in Archway considered two time periods in deciding whether the payments made to DFI fell within the ordinary course of business safe harbor.  From October 6, 2206 to July 7, 2008, Archway paid DFI’s invoices between 21 and 177 days after invoice (the “Historical Period”).  Further, from July 8, 2008 to October 6, 2008 (the “Preference Period”), Archway paid DFI’s invoices between 33 and 64 days after invoice.  Opinion at *3-4.

Relevant Factors

There are two ways to prove the ordinary course of business defense:  the “subjective test” and the “objective test”.  The subjective test looks to whether the transfers between the parties were made in the ordinary course of business.  The objective test, on the other hand, looks to whether the transfers were made according to “ordinary business terms.”  In Archway Cookies, DFI argued that the payments it received from Archway were protected under the “subjective test” (i.e. the payments were ordinary as between Archway and DFI).

In deciding whether to apply the ordinary course of business defense using the subjective analysis, the Court looked at factors such as (1) the length of time the parties engaged in the type of dealing at issue; (2)  whether the transfers were in an amount greater than what was usually paid; (3) whether the payments at issue were made in a manner different from prior payments; (4) whether there was unusual collection activity; and (5) whether the creditor did anything to gain an advantage over the debtor.  Opinion at *11-12.

Court’s Analysis

The court first considered the length of the parties’ relationship.  This is significant because in deciding whether to apply the ordinary course of business defense, the court had to determine whether the parties’ relationship was of “recent origin” or one that is “cemented long before the onset of insolvency.”  Opinion at 12-13, citing In re Molded Acoustical Products, Inc., 18 F.3d 217, 219 (3d Cir. 1994).  Archway and DFI had a two-year relationship during which there were 117 transactions between the parties. Opinion at *13.  Based on this time period and the number of transactions, the court found that the relationship was of “sufficient length to establish an ordinary course of dealing between the parties.”

Next, the court looked at the similarity of transactions in the Historical Period and the Preference Period.  Based on the facts before it, the court found there was no evidence that the payments were inconsistent with the practices between the parties.  By this, payments during the Historical Period ran from 21 to 177 days, averaging 42.3 days.  During the Preference Period, payments ranged from 41 to 64 days, averaging 47.2 days to pay.  Opinion at *15.  This difference, the court found, was not material.  Further, the Trustee presented no evidence of differing payment practices between the parties.  Id. Based upon these findings, the court found that the practices between the parties were consistent with their historical dealings and summary judgment was appropriate.  Opinion at 17.

Conclusion

Preference actions are fact senstive proceedings that often center around the course of dealings between the parties. The Archway decision reminds readers that creditors can, in some instances, establish a solid ordinary course relationship in a relatively short amount of time – two years.  Further, Archway shows that the range of payments may vary, yet still remain within the protections of the ordinary course of business defense.  A copy of the court’s decision in Archwary is available here.

Introduction

Earlier this month, the Liquidating Trustee in the Intermet bankruptcy filed preference actions against various defendants.  This post will look at the nature of Intermet’s business, why the company filed for bankruptcy and the circumstances behind the formation of the Liquidating Trust that is pursuing the preference actions.

As I often do on this blog, much of the information used in this post comes from information provided in the Debtors’ Declaration in Support of its Chapter 11 Petitions.  Intermet filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on August 12, 2008 (the “Petition Date”).  In support of its bankruptcy filings, Intermet filed a Declaration of William H. Whalen, Intermet’s Chief Financial Officer (the “Whalen Declaration”).  The Whalen Declaration provides a good summary of Intermet’s business operations and the events leading the company into bankruptcy.  A copy of the Whalen Declaration is available here.

Intermet’s Operations

Intermet Corporation manufactures automotive cast components such as power trains, chasis and interior components used in automobiles.  The company sells auto parts to over 30 major auto manufacturers and parts suppliers.  At the time of Interment’s Petition Date, the company’s customers included Chrysler, Ford, Honda, the Delphi Corporation and Dana Corporation.  Whalen Decl., p. 3.

Events Leading to Bankruptcy

It is common knowledge that the U.S. auto industry has suffered from a decline in global demand over that past several years.  This drop in demand, especially for SUVs and larger vehicles, has resulted in increased inventory and overcapacity for auto parts suppliers.  Intermet’s problems, like the auto industry in general, were compounded by an increase in the cost of raw materials at the same time it was experiencing substantial drop in demand for its products.

Prior to filing for bankruptcy in 2008, Intermet closed a manufacturing facility in Tennessee and implemented “lean manufacturing techniques” designed to reduce the number of employees on the company’s payroll.  Although Intermet considered its cost cutting measures a success, the “unprecedented drop in sales” was too great for the company to operate at a profit.  Intermet filed for bankruptcy hoping to further restructure its operations and debt, and at the same time consolidate its business operations.  Whalen Decl., p. 9.

Formation of the Liquidating Trust

On June 16, 2009, the Delaware Bankruptcy Court entered an Order Confirming Intermet’s Chapter 11 Plan.  Pursuant to Intermet’s Plan, a Lender Liquidating Trust was created to collect and distribute certain assets belonging to Intermet.  Included in the assets assigned to the Liquidating Trust are the preference actions Intermet could bring under section 547 of the Bankruptcy Code.  The Liquidating Trustee identified as the Plaintiff in the preference actions is the Liquidating Trustee created following the formation of the Liquidation Trust.  The Intermet bankruptcy proceeding, as well as the avoidance actions filed by the Liquidating Trust, are before the Honorable Kevin Gross of the Delaware Bankruptcy Court.

Introduction

In July of this year, Ascendia Brands, Inc., began filing preference actions against various defendants who allegedly received payments from Ascendia.  According to the complaints, the defendants, many of whom were former customers of the company, received “avoidable” payments either before or after Ascendia filed for bankruptcy.  Citing various provisions of the Bankruptcy Code, Ascendia alleges that the recipients of these payments are required to return the funds to Ascendia.  This post will look briefly at Ascendia’s business operations, why it filed for bankruptcy and what the next steps will likely be for the preference actions Ascendia filed with the Bankruptcy Court.

Ascendia’s Business

Ascendia manufactures and sells health and beauty products throughout North America and across the globe.  According to the Declaration of Douglas Booth, Ascendia’s Chief Restructuring Officer, Ascendia distributes its products through “mass merchants” such as Walmart, Target, Walgreens and Dollar General Stores.  See Booth Decl, pghs. 5-6.  A copy of the Booth Declaration as originally filed with the Delaware Bankruptcy Court is available here for review.

In 1920, Ascendia started as the Lander Co., Inc., selling cosmetics within the United States.  From 1920 to 1950, Lander Co. grew to thirty brands and four subsidiaries.  In 2003, a private equity firm, Hermes Group, LLC, acquired Lander Co..  Two years later, Hermes merged with Cenuco, Inc..  Following the merger of Hermes and Cenuco, the merged entity changed its name to Ascendia Brands, Inc..  Booth Decl., pghs. 7-8.

Events Leading to Bankruptcy

Starting in early 2008, Ascendia’s revenues fell below the company’s forecasted projections.  The company attributed the drop in revenue to higher than expected costs and lower than expected sales from the company’s “Healing Garden” and “Calgon” line of products.  In addition, and like many other debtors before it, Ascendia points to the overall decline in economic conditions and the negative effect such conditions have had on the company’s profitability.  Booth Decl., pghs. 40-41.

Ascendia filed for bankruptcy on August 5, 2008 (review Ascendia’s Bankruptcy Petition here).  In the months prior to bankruptcy, Ascendia sustained net operating losses of $7.1 million (June 2008) and $9.2 million (May 2008).  Prior to bankruptcy, Ascendia began discussions with its lenders regarding a possible restructuring of the company or a sale of assets.

After filing for bankruptcy, Ascendia conducted a sale of assets under section 363 of the Bankruptcy Code.  On November 25, 2008, the Bankruptcy Court approved an asset purchase agreement between Ascendia and Ilex NewCo. LLC.  A copy of the Order approving the sale to Ilex is available here.

Procedural Posture of the Preference Actions

At the time of this post, many of the adversary actions filed by Ascendia do not include Summons.  The Summons often will state the date of the first pretrial status conference scheduled before the Court.  Once a pretrial status conference is scheduled, Plaintiff’s counsel may begin to circulate a proposed scheduling order similar to the scheduling order that is often used in this jurisdiction.  A copy of the form scheduling order provided by the Delaware Bankruptcy Court is available here for review.

The Ascendia bankruptcy proceeding is before the Honorable Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware.  Plaintiff’s counsel is represented by Young Conaway Stargatt & Taylor LLP.

Introduction

Recently, the LandSource Creditor Litigation Liquidating Trust (the “Litigation Trust”), commenced various avoidance actions in the United States Bankruptcy Court for the District of Delaware.  This post will look briefly at the events leading to the commencement of this bankruptcy proceeding. Further, the post will look at some of the issues that confronted the Debtor during the reorganization process.

Background

LandSource Communities Development, LLC (“LandSource”), filed petitions for bankruptcy on June 8, 2008.  LandSource is a home builder.  Like other builders throughout the U.S., the company was severely affected by the decline in the U.S. real estate market, as well as the decrease in the availability of credit following the subprime mortgage crisis.  The drop in the demand for housing led to increased inventories of homes for builders.  This further depressed prices, worsening conditions even more for LandSource.

In January of 2008, LandSource was found to be in default of its prepetition loan agreements.  Specifically, the company exceeded the credit exposure limit due to the drop in value of its developed and non-developed property.  Despite entering into forbearance agreements with its lenders, LandSource was unable to restructure its debt without bankruptcy court protection.

Events During the Bankruptcy Proceeding

From the start, it was important that LandSource receive postpetition financing.  Under the debtor in possession financing agreement, LandSource was required to file a plan of reorganization by October 6, 2008.  By October 18, 2008, LandSource had failed to file a plan of reorganization resulting in its First Lien Lenders filing their own plan of reorganization.  Under the Lenders’ Plan, there would be an auction to sell off the company’s assets.

As economic conditions worsened, LandSource and its lenders determined that an auction to sell off assets was not feasible.  Instead, the parties agreed to a plan that reorganized LandSource as a going concern.  Under the revised plan, unsecured creditors would receive cash payments versus equity in the reorganized company.  Once the plan became effective, Lennar Corporation, a partner of LandSource, agreed to invest over $138 million in the newly reorganized company.

Commencement of the Preference Actions

On July 20, 2009, approximately 13 months after filing for bankruptcy, the Bankruptcy Court entered an order confirming LandSource’s Second Amended Chapter 11 Joint Plan of Reorganization (the “Plan”).  LandSource’s Plan became effective July 31, 2009.  Pursuant to the Plan, preference actions belonging to the bankruptcy estate were assigned to the Litigation Trust.  Under the Order confirming LandSource’s Plan, KDW Restructuring & Liquidation Services LLC was appointed the Litigation Trustee.

Pachulski Stang Ziehl Young and Jones serves as Plaintiff’s counsel.  This bankruptcy proceeding, along with these avoidance actions, are before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court.  For further information regarding this bankruptcy proceeding, see the Memorandum of Law in Support of Confirmation of the Second Amended Joint Plan, filed by Barclays Bank as administrative agent.  A copy of Barclay’s Memorandum is available here.  Prior posts from this blog concerning Delaware preference litigation are available here.